The thoughts of Michael Cadwallader. Coffee loving, history book reading, Cheshire man.

Tuesday, June 13, 2006

Economic Warnings (Continued)

Last month, I commented on the economic wobble that we were about to hit. The wobble has been rumbling on and on with peaks and troughs in the stock market, usually dependent on what Ben Bernanke has been saying. The market has been deflating regulary over the last month, today it fell sharply again, before rallying towards the end of the trading day.

Over this period I was wondering whether Mervyn King would react, yesterday I got my answer. And despite the morning newspaper headlines mentioning "King's warning", it seems that King's plan consists of doing....well, nothing at all.

The Bank of England will "monitor carefully" households' rising inflation expectations, Mervyn King said yesterday as official figures showed a sharp rise in the price of both houses and factory goods.

But the Bank's governor said pay pressures were "muted" in the face of soaring oil prices, which would dampen growth of consumer incomes and spending.

As I said in my previous post, high energy prices are here to stay. That was born out again by today's inflation report.

Energy bills helped to push UK inflation up to 2.2% in May, from 2% the month before, official figures have shown.

The move means that the Consumer Prices Index (CPI) rate of inflation has now risen above the government's 2% target.

The headline rate of RPI inflation, which includes mortgage interest payments, rose from 2.6% to 3%.

So, despite manufacturing goods reaching an eight month high level, and the housing market gaining pace again, the BofE's only response is to "monitor carefully" the situation. Unlike Bernanke and despite Gordon Brown's pledge to be "resolute in our anti-inflation discipline", it can be inferred that King's plans to brave things out. So why has King taken this approach?

The problem with energy driven inflation is that is not only causes inflation to rise, it also causes growth to stop. The result is the dreaded stagflation of the 1970s. King obviously wants to avoid this situation. His response is - unlike Bernanke - to keep interest rates reasonably low in an attempt to ride out the storm, and to keep the credit fuelled spending going. I can only presume that King, like many others, is waiting for the inflationary pressure to dissipate.

Today, the International Energy Agency will issue its monthly report. Within it, will be the latest figures on worldwide oil inventories. If the inventories have not been rising then energy costs are going to get higher and higher. Today also saw the start of the hurricane season. The warning turned out to be a damp squib, but what chance another Katrina in the next 3 months? It will only take one hurricane in the gulf region, to cause another short term spike in energy prices. Would it not be more prudent to deflate the housing boom and keep consumer led inflation down now?

A lot depends on that energy report, but if things go badly then King's "bumpy road" could turn out to be a muddy track, with the wheels firmly stuck.